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Firm's Protection against Disasters: Are Investment and Insurance Substitutes or Complements?

Giuseppe Attanasi (), Laura Concina, Caroline Kamate and Valentina Rotondi ()
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Laura Concina: FONCSI, Toulouse
Caroline Kamate: FONCSI, Toulouse

No 2018-24, GREDEG Working Papers from Groupe de REcherche en Droit, Economie, Gestion (GREDEG CNRS), University of Nice Sophia Antipolis

Abstract: We use a controlled laboratory experiment to study firm's and insurer's behavior when the firm can protect itself against potential technological damages. The probability of a catastrophic event is objective, and the firm's costly investment in safety reduces it. The firm can also buy an insurance with full or partial refund against the consequences of the catastrophic event, which ultimately reduces the variance of the firm's investment-in-safety lottery. In the insurer-firm game, first the insurer decides which contract to propose to the firm, then the firm simultaneously decides whether or not to buy this contract and whether or not to invest in the reduction of the probability of the catastrophic events. We parametrize the insurer-firm game such that: (i) a risk-neutral insurer maximizes his expected profit by o↵ering an actuarially fair contract with full insurance; (ii) a risk-neutral firm is indi↵erent between investing in safety and accepting a fair insurance contract. We aim at understanding whether investment in safety and insurance are substitutes or complements in the firm's risk management of catastrophic events. In line with our predictions, the experimental results suggest that they are substitutes rather than complements: the firm's investment in safety measures is a↵ected by the insurer's proposed contract, the latter usually involving only partial insurance.

Keywords: Decision under risk; Losses; Small probabilities; Probability reduction; Technological disasters; Insurance; Deductible (search for similar items in EconPapers)
JEL-codes: D81 G22 K32 Q58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cta, nep-exp, nep-ias and nep-rmg
Date: 2018-10, Revised 2018-12
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Downloads: (external link) Revised version, 2018-12 (application/pdf)

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